This article is a Chapter in a Book Called “What’s Wrong With Microfinance?”, Edited by Thomas Dichter and Malcolm Harper.

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Abstract - The Moneylender’s Dilemma

In the late 1980s Catholic Relief Services joined the microcredit industry and its evolution from economic provider to global moneylender. Along the way, CRS learned that through microcredit the poor were poor twice, once from initial circumstance and again from high interest rates. Though best practices argued for high interest as a route to sustainability, best practitioners operated in contexts where few laws protected consumers, where consumers were desperate and where subsidies surged, but not to clients. While these conditions welcomed the profiteer, they repelled CRS. In 2005, CRS decided to fully divest its holdings in microcredit in favor of savings-led microfinance.

The Moneylender’s Dilemma

By Kim Wilson[1]

As he went through town that day he was obsessed with thoughts of money. His mind rang with the words he had said to villagers: ‘I am only trying to help you get out of your money worries’. He began to believe it himself. He saw himself a saviour of mankind.

The Financial Expert, R.K. Narayan

In 2005 Catholic Relief Services issued to its field offices a paper called Microfinance 2010, which mandated divestiture of all microcredit holdings within five years.

Microfinance exacts a toll on the agency. Due to their special requirements, MFIs chafe at our financial, audit and accounting systems, human resource policies, and annual planning process. Questions of subsidiarity come into play, and our explicit mission to serve the poor and marginalized may not receive the same attention as concerns for financial profit. This confounds us. Do we continue along a path pronounced good by serious international donors or do we follow the wisdom of our principles (CRS, MF 2010)?

CRS was getting out of the moneylending business. The agency would no longer invest in new microcredit institutions (MFIs) and would phase out its MFI loan and equity portfolios. It would support MFIs in finding other investors and lenders but would itself disengage as an investor or lender.

The decision to step back from credit was sweeping and controversial. It came at a time when some CRS’ microcredit programs were quite profitable, when the agency’s coffers were flush with private and public money, and when CRS’ new fund dedicated to microcredit – Lifelines – was doubling in size.

For years CRS had advanced along the frontiers of lending, confident in its benefits. Now within a matter of months the agency was in full retreat. On the surface the question was: how could CRS make such a cavalier about-face? But the evidence had been mounting for years. The deeper question was: What took us so long?

In such a large and decentralized agency, where carrying on is far easier than changing course, I am surprised we made the decision at all. It took an enormous force of will for so many to come together and decide ‘enough’, that doing-well-by-doing-good had become a conceit and had outlived its usefulness, that it was better to face the sting of peers and the ‘best practices’ hegemony, and better to reject the promise of more funds than to keep up the charade.

The dilemma for CRS was that we had become a moneylender, a subsidized one. Perversely, the subsidies never traveled to the poor in the form of low interest rates, great service, or social impact, but stayed within the confines of our partner microfinance institutions, often off the MFI’s books. We had not attained the double bottom-line where financial profit matches social returns. In aggregate, we had attained neither bottom-line but the purgatory of a double top-line, where MFIs benefited from both subsidy and extraordinary rates of interest.

An Abbreviated History
With $25,000 and a pledge to follow a documented methodology, CRS bought the Village BankingTM package from FINCA International. It was the late 1980s and microcredit seemed unrivalled in its power to change the economic fate of vast numbers of poor people. Inadequate credit was considered the primary barrier to financial opportunity for the self-employed – which described many of the people the agency aimed to serve. Loans used productively could boost a marginal activity like selling charcoal, tea or shea nuts into a prosperous family business. Village banking not only represented vital resources for the agency’s primary clientele, it conferred other benefits as well - social cohesion and empowerment among them. Most important, village banking was something that CRS’ thousands of grassroots partners could do. It was systematic, simple, and easily mastered by local staff. In those days village banking had a beginning, a middle, and an end. After nine or so rounds of external loans from the partner-lender, borrowers within a village bank could pool enough savings to meet local credit needs. The partner could shift its loan capital to a new community.

The simplicity of microcredit paved the way for expansion. CRS could capitalize on its thousands of grassroots partners and help them bring financial resources to the most rural locations.

In the 1990s microcredit broadened its scope to include all forms of finance to the poor, yet most programs still focused on credit. The prevailing practice was for organizations like CRS to help local partners create sustainable institutions. Borrowers it seemed wanted more money than their group funds would supply. By charging higher rates of interest and providing continued credit to an ever-growing base of borrowers, partners could sustain credit operations indefinitely. However, microcredit was no longer something every partner could do. It had become a specialized business that warranted technical expertise. The agency in the mid-1990s began to push for the formation of independent microcredit businesses that would merit the investment of commercial sources of capital.

By 2005 CRS supported microcredit in 21 countries with an agency portfolio of about $19 million and far more on the books of partners. Some programs followed a modified village bank methodology. Others were Grameen replicators. Still others adopted the solidarity model. All were similar in that partners used group-guarantees as the primary means of security. All included a savings feature of some sort (or were supposed to) and all were to focus on women. The agency had developed a set of standards for reviewing program performance, engaged a network of microfinance advisors worldwide, and invested substantial public and private funds in microfinance activities. CRS was supporting loans to hundreds of thousands of clients in Europe, Asia, the Middle East, Latin America and Africa. In total CRS managed seventeen country programs that had some form of financial relationship with one or more MFIs and four country programs directly involved with wholesale microfinance institutions.

Following is a personal reflection on the many small awakenings that led CRS to stop seeing microcredit as a strategy to uphold its mission and start seeing microcredit as an obstacle to achieving it.

A Night to Remember

I attended a conference of practitioners, many from CRS but other NGOs as well, in the mid-nineties. Microcredit had unofficially morphed into microfinance. New to the industry, I felt as though I had stepped through a portal to an alternate universe. Steered neither by commerce nor charity yet drawing on both, this universe enjoyed its own language, which brimmed with commercial diminutives. Microentrepreneur substituted for rag-picker or street hawker and microsavings replaced involuntary acts of thrift. Small grants became microequity and lenders were now microbankers.

The kick-off dinner of salads, fruits, sautéed sole, cheeses, wines and deserts, was interrupted by a surprise. The kitchen staff - cooks, waiters, dishwashers - walked into the dining hall and encircled the tables, then began a gentle applause. Someone took the mike and announced the staff had learned that the topic of the dinner was microfinance and that they wanted to wish us well. They had relatives in other countries who could benefit from small loans.

For a magic moment I am absolutely certain that every dinner guest in that room was transfixed, thinking the same thing as I. In ten years time how would our well-wishers see us? As social pioneers, merchant profiteers, or naked emperors? The gesture took us off guard. It was not the usual form of village gratitude to which many at my table had become inured. Or the mistaken praise of friends who thought microfinance work as self-sacrificing. This applause was utterly unexpected and sobered our shoulder-slapping bonhomie. We accepted the appreciation with smiles and a promise that one day we would deserve this gesture. Were we up to the task? Would we be heroes or frauds?

New Curators in the Museum of Poverty

In the early days of microcredit, a few protocols steadied our work. ‘Do not accept late payments or partial payments; do not allow men into loan groups; place all loans into income generating activities.’ But soon any deviation from the norm provoked frowns from the ranks of practitioners.

By the mid and late nineties we had fossilized. Neither commercial nor charitable we were subject to the new rules of best practice, which had assumed a papal infallibility. Perhaps the most jarring ‘best practice’ was a commitment to charge market rates of interest. It was never clear what charging market rates meant in the economies where CRS worked, other than charging as much as possible. One program priced its loans at 87% per year in a country with limited inflation. The poor had become the new consumers of debt, fisherman who might fish for a lifetime on an endless line of loans.

It bothered us a little that local moneylenders receiving no subsidy would charge these rates but it bothered us a great deal more that all the grants, technical assistance, and idealism that accompanied our own investment held the power to generate such unfettered predation. It seemed that the only thing we were likely to sustain was poverty.

The Clash of Civilizations

The call for specialized field staff in specialized institutions - a cornerstone of classic microfinance – can collide with agency reality. (CRS, MF 2010)

The circle that practiced microfinance was no longer a rag-tag collection of development workers but an entrenched set of experts. The agency had begun to see sectoral divides that were not necessarily good for a global institution. CRS staff working in microfinance as advisors or project managers, or in some cases as managers of microfinance institutions (in the absence of independent local partners) had become isolated from other activities of the agency. The fault lines deepened.

We were just doing our job, which was to focus on microfinance. But the synergies that might have happened between sectors, for example between agriculture and microfinance - a natural pair in rural economic development - were not taking place. One part of the agency was intent on building sustainable businesses (MFIs) or helping partners to build them, and all other parts were seeking to deliver humanitarian or development services. Barriers between microfinance and other sectors rose, threatening a kind of balkanization that seemed less like healthy rivalry and more like a cold war.

A Well-Oiled Machine

‘That all forms of microfinance consume funds over many years challenges its original claim to self-generate sustainable financial benefits. And while microcredit has proved capable of covering operating costs with operating revenue, it has proved incapable of covering the costs of start up (seed capital) or technical assistance, or of critical management positions.’ (CRS, MF 2010)

The amount of working capital and technical assistance needed to transform a microlending program into a self-propelled credit machine proved gargantuan. By the calculation of some, and it was anybody’s guess, an emerging MFI required an investment – net of any interest income or loan funds – between $150 to $300 per client.

As one regional director quipped: If microcredit is so sustainable, why is my program so broke? Microcredit indeed had become a leaky ship and some of the funds it siphoned off were undesignated, meaning they could have been used for schools, clinics or agriculture. In the minds of a few, microcredit costs had become synonymous with opportunity costs. Did we continue to pump funds into the abyss or did we start to compare microcredit costs and benefits to other development programs?

We chose the latter but found it next to impossible to actually determine what it cost to start and sustain a viable, growing microfinance institution. To disentangle microcredit expenses from shared program costs required a hair-splitting calculus that few of us could do. Also, many costs were buried in line items for training, advisory staff and other support. Often key management positions in an MFI, particularly expatriate positions, fell onto CRS’ books, omitted from the MFI’s profit equation. Also omitted were international travel and the cost of consultants. And once loan funds washed in and out of CRS financial machinery a few times, whether we capitalized or expensed them became a matter of donor preference, further complicating cost estimates.

The industry could only provide data which MFIs themselves supplied. Additional costs that international agencies took on were uncalculated or undisclosed. We did not know if other agencies were reluctant to share true costs or if they were like us and just didn’t know them. To gauge cost-benefit we were stuck with dead-reckoning. Our guess was that microfinance was a financial sinkhole.

Change Agents

During the last interview in a day marked by dreary conversations, a well-schooled job applicant said: ‘I like the clear rules of village banking. I will enjoy managing them.’ She had boned up. We responded: ‘Though we have a solid system to follow, the program needs a leader to make sure its services please clients, and even inspires them. We are looking for someone who can empower women, provoke change.’ She stared at us blankly. We were in search of a firebrand and our best candidate wanted to run a 7-Eleven, her next interview.

It was 1998 and I had accompanied colleagues to Thailand. We had been interviewing candidates throughout the long, hot afternoon in hopes of finding someone to oversee our village banking organization. Discovering a leader who might turn the program away from investing in the petrol stations of board members - its latest expression of mission drift - and toward helping the poorest farmers was proving difficult. We wanted more than mission realignment; we were seeking a hero who could motivate staff and transform the lives of the poor. It did not occur to us then as it would later that credit management is a take-no-prisoners war against risk. And risk avoidance calibrated perfectly with a paint-by-the-numbers village banking approach. But, could someone who thrived on tamping down risk – the very quality required to run a credit program -inspire the kind of transformation promised by microfinance?

Dodging the Bishop

‘I want to close this program’ said Farther Paul, though it was covering costs with interest. ‘I am doing it now to please CRS. We are not reaching the far-flung hamlets. The need for assistance is greatest there. The roads are dirt and rough, sometimes impassible. The people living in the interior need far more support than those living near a road. And then there is the interest rate. If I am going to take on the expense of operating an MFI, I will have to charge high rates, nearly the rate of the local moneylender. If I do that, I will have to dodge the Bishop. He would never tolerate such a thing.’

Though CRS has many kinds of partners, two categories are relevant here: MFI partners that are financial institutions and grassroots partners. CRS supports fewer than fifty microfinance partners (including the institutions CRS started) but thousands of grassroots partners scattered throughout the poorest rural areas of the world. Their programming varies widely. Some emphasize education or health, others agriculture or water, child protection, disaster response, and still others HIV/AIDS and malaria prevention and care. Many focus on a rich blend of these activities. They served remote locales often prone to calamity, or with very vulnerable populations. For these partners, microcredit did not work.

Serving Two Masters

Partner staff at one time (pre-best practices) could afford to show genuine care for their clients and spent extra time to find doctors, veterinarians, or agricultural extension workers. They helped deliver babies and cows and tended sick children. They lent emergency money from their own pockets. They worked long hours walking or riding on isolated, dangerous roads with women staff frequently compromising their own safety. They helped buy livestock, advised on kitchen gardens and encouraged borrowers to send their children to school. Perhaps they could have been more efficient and delegated community work to others. But in many place there were no others. Our partner was the only game in town.